Flagship Report: The Distributed...

Flagship Report: The Distributed Marketplace

Dissecting the "Sharing Economy": Business model opportunities and risks

Redefining “sharing economy.” A “distributed marketplace company” (DMC) develops and manages an automated platform that enables self-organized, usually ad hoc transactions between two independent parties, a user/consumer and a provider, in order to use otherwise slack resources. Between Uber’s $50 billion valuation, Etsy’s IPO and the large venture capital infusions into Airbnb, DMCs have clearly attracted investor interest, as well as scrutiny.

A matter of trust. A core component of a DMC’s value lies in its ability to gain the support of stakeholders—not only customers and providers, but also incumbents, suppliers, communities, regulators and investors—and facilitate relationships among them. As DMCs grow, one of their primary challenges is maintaining the trust of these disparate stakeholders.

Where is trust at risk? We have identified the salient characteristics of DMCs; all of these companies sit somewhere on the continuum for each characteristic. Assessing where a company lands on the continuum can highlight the opportunities and risks presented by its business model.

A closer look at Uber. Uber continues to grow quickly many in the media speculate that the firm will go public. Meanwhile, the company faces regulatory risk because it has riled its traditional taxi-service competitors as well as local governments. We look at the economic implications for Uber should regulatory or social pressure require it to change its pay model. As it stands currently, we calculate that there is no significant pay advantage for Uber drivers relative to taxi/limousine drivers, which would pose a risk to Uber if it had to adhere to stricter regulations.

A comparison. We also sat down with the CEO of Cargomatic (often referred to as “the Uber of trucking”) to gain an insider’s perspective on the challenges and opportunities facing this new breed of company.

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John Wilson Head of Corporate Governance, Engagement & Research 212-874-7400

Margarita Pirovska Policy and Sustainability Analyst 212-874-7400

Michael Shavel Global Thematic Analyst 212-874-7400

Global Thematic Research June 9, 2015

mailto:[email protected]


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2 Please see important disclosures at the back of this report.

Table of Contents

Executive summary ............................................................................................................ 3

What questions should investors be asking? .................................................................. 4

Applying the taxonomy ............................................................................................................ 4

The sharing economy hits adolescence ...................................................................... 5

Market structures ............................................................................................................... 6

Why peer-to-peer networks are flourishing ................................................................... 7

DMCs: P2P networks on steroids ........................................................................................ 8

Business Model Taxonomy ............................................................................................ 10

Assets Labor ........................................................................................................................ 11

Cooperative For-profit .................................................................................................... 12

Regulatory Clarity Regulatory Ambiguity ............................................................... 13

Pioneers Disruptors ......................................................................................................... 14

Amateurs Professionals .................................................................................................. 15

Autonomous Directed ...................................................................................................... 16

Global Local .......................................................................................................................... 17

Applying the DMC taxonomy ......................................................................................... 18

Why take a closer look at Uber now? .............................................................................. 18

Interview with Jonathan Kessler – Co-Founder and CEO, Cargomatic ............ 23


Executive summary

Between Uber’s $50 billion valuation, Etsy’s IPO and the large venture capital

infusions into Airbnb, the “sharing economy” is transitioning from a social

movement to a large-scale commercial business model. As more technology-

driven sharing enterprises inevitably go public (or expand via large private

equity infusions), investors will need consistent ways to evaluate not just the

financial prospects of a company, but also whether its business model will be

sustainable as it matures. In this report we lay out a methodology that can be

used to do so.

We call companies that have shifted beyond the original socially focused ethos of

the sharing economy to become more profit-oriented “distributed marketplace

companies” (DMCs). We define DMCs as companies that develop and manage an

automated platform which enables self-organized, usually ad hoc transactions

between two independent parties, a user/consumer and a provider, in order to

use an otherwise slack resource. A DMC is a more formalized version of a “peer to

peer” network.

While they may be classified as technology companies for the purposes of

fundamental analysis, DMCs enable commercial transactions in such diverse

sectors as transportation, apparel, hospitality, the arts and household goods and

services. Moreover, a key component of their value lies in DMCs’ ability to gain

the support of stakeholders and facilitate relationships among them. These

companies will prosper based not only on financial performance, but also on the

creation and maintenance of trust with stakeholders--customers and providers,

but also competitors, suppliers, communities and regulators. As DMCs grow, the

interests of these indirect stakeholders take on greater importance. The way in

which a DMC addresses the concerns of these other stakeholders may ultimately

determine whether its business model proves sustainable over the long term.

DMCs may create greater employment and less expensive consumption

opportunities, as well as more efficient and environmentally friendly use of

physical capital. On the other hand, the decentralized nature of DMCs may also

entail the circumvention of consumer and worker protections as well as safety

standards, or may exacerbate income inequality. Creating and maintaining trust,

a key component of the sharing economy, depends in part on avoiding the

perception that some stakeholders are benefiting at the expense of others.

Moving beyond “shared economy” to “distributed marketplace”

As DMCs mature, they will need to reconcile their innovative business models with traditional business responsibilities

Shares of Etsy (ETSY, $14.86 as of June 8 close) have declined by close to 60% from its IPO price of $37.54, following allegations that as much as 5% of the merchandise being sold on the company’s site is counterfeit. Investors have brought a class-action suit against the company, alleging fraud. Of larger significance than the potential legal action is the possibility that consumers will lose trust in the products available on the website. Since the products flow from the “distributed marketplace” rather than the company itself, the company cannot simply put into place additional compliance measures but must rely on the ability of the marketplace to self-enforce. Etsy’s challenge is especially daunting considering Amazon, which has a strong reputation for product integrity, is preparing to enter the market as a competitor.


What questions should investors be asking?

Given the diversity of business models within the sharing economy, the right

questions will depend upon the specific company under consideration. We have

created a taxonomy to identify the salient characteristics and key relationships in

the distributed marketplace, and to help evaluate the risks and opportunities

associated with each business. Companies can have a mix of characteristics, any

of which can present a particular opportunity or risk. In all cases, the analysis

comes down to who benefits and how, who might be harmed and how, and what

stakeholders other than the provider and consumer may be affected.

Figure 1: Distributed marketplace taxonomy

Resource: Assets Labor

Purpose: Cooperative For-profit

Regulatory framework: Clarity Ambiguity

Business model: Pioneer Disruptor

Provider status: Amateur Professional

Autonomous Directed

Provider’s potential geographic reach:

Global Local

Distributed marketplace company characteristics

Source: Cornerstone Capital Group

Applying the taxonomy

Given recent controversies over Uber’s corporate governance and whether

drivers should be considered employees, we take a look at the economics of

being an Uber driver, and the implications for Uber should regulatory or social

pressure require it to change how it pays. With many in the media speculating

that Uber will go public, its ability to adapt with changing expectations is a key

issue for the company and its prospective investors.

We also look at Cargomatic, sometimes called “the Uber of trucking,” for more

insight into the opportunities and challenges they face, some of which apply to

DMCs more broadly.

As more DMCs achieve market-changing scale, we intend to apply our

methodology to provide insight into their likelihood of continuing to thrive.

Does it pay to be an Uber driver?


The sharing economy hits adolescence

According to the website The People Who Share, “The Sharing Economy is a

socio-economic ecosystem built around the sharing of human and physical

resources. It includes the shared creation, production, distribution, trade and

consumption of goods and services by different people and organisations.”

At the center of this economy are the platform companies that bring together

individuals for the purpose of sharing. We call these companies Distributed

Marketplace Companies (DMCs).

A distributed marketplace company develops and manages an automated

platform which enables self-organized, usually ad hoc transactions between two

independent parties, a user/consumer and a provider, in order to use an

otherwise slack resource.

DMCs may support numerous kind of transactions. Juliet Schor of Boston College

summarizes the major business models*:

1) Recirculation of goods, including such companies as Ebay and Craigslist

that allow participants to (among other activities) sell used items.

2) Increased utilization of durable assets, including companies such as

Zipcar and AirBnB that allow access to durable goods without ownership;

3) Exchange of services, such as Task Rabbit or Mechanical Turk, which

facilitate trade in ad hoc labor services; and

4) Sharing of productive assets, which allow the collaboration in

production rather than consumption. These may include shared offices

and open source efforts. Few have been commercialized to date.

The sharing economy was founded on an ethos of collaboration for mutual

benefit. However, as the basic concept has taken hold, entrepreneurs have shifted

the emphasis from “open-source” collaborations to commercial enterprises.

We refer to profit-seeking platforms as “the distributed marketplace,” an analogy

to “distributed energy” systems that generate energy locally rather than through

centralized power generation facilities. As information costs decline, it is less

necessary to conduct commercial transactions through traditional companies.

Technology enables the establishment of decentralized markets that match

* “Debating the Sharing Economy,” by Juliet Schor, October 2014, Tellus Institute http://www.greattransition.org/publication/debating-the-sharing-economy#sthash.wmJBBLoz.dpuf

The sharing economy was founded on an ethos of collaboration for mutual benefit

http://www.thepeoplewhoshare.com/

http://www.greattransition.org/publication/debating-the-sharing-economy%23sthash.wmJBBLoz.dpuf

http://www.greattransition.org/publication/debating-the-sharing-economy%23sthash.wmJBBLoz.dpuf


buyers and sellers on an ad hoc basis, avoiding the costs and inefficiencies

associated with formalized corporate management systems.

The transition from sharing economy to distributed marketplace may bring

about greater economic efficiency, increased access for consumers as well as new

investment opportunities. However, if companies achieve scale but abandon the motivation of shared value, they risk alienating the community of providers and

users that underpin the company’s value. The distributed marketplace cannot be

sustained without trust.

Because distributed marketplace companies exist to make connections among

large numbers of people, investment analysis of these companies must

incorporate an evaluation of their governance systems as well as their social

impact (and possibly their environmental impact). Investors should have an

understanding of the strength of a company’s networks, or the risks that

companies face if those networks fracture.

Market structures

Two types of economic entities dominate most markets: companies, or

hierarchical structures employing labor and capital to produce goods and

services, and individuals, both as suppliers of labor and consumers of products

and services. Companies arise to address problems coordination, information

sharing and trust-building that limit the development of markets involving only

freely interacting individuals. While this model was successful enough to enable

the industrial revolution and related benefits, it entails high costs and produces

natural slack – unused capacity of physical assets and labor – which is also an

untapped value reserve.

Such slack may be particularly pronounced where barriers to entry lead to

monopolies or oligopolistic competition, for example in the case of networked

services overseen by regulated monopolies, such as municipal taxicabs.

Dissatisfaction with the monopolies or oligopolies among both providers and

consumers may create the conditions favorable to substitution for the network

itself.

In other cases, the difficulty or expense of matching providers and users through

traditional corporate structures exceeds the value of the market.

Peer-to-peer (P2P) networks may arise to address these gaps. Such a structure

is a hybrid between companies and individuals – it provides the essential

coordinating, information sharing and trust-building function of companies,

while allowing individuals to retain their autonomy.

Slack – unused capacity of physical assets and labor – is also an untapped value reserve

As DMCs grow, the concept of shared value can be put at risk

Peer to peer networks arise to address gaps in companies’ ability to match providers and users


Figure 2: Traditional vs distributed marketplace


Why peer-to-peer networks are flourishing

While economic systems based upon sharing or peer-to-peer transactions are as

old as humanity, in recent times a confluence of factors has increased their reach

and sophistication. Relevant factors include:

Economic:

Rising interest in increasing “sustainability” through reduced waste and

increased efficiency.

Persistent unemployment and/or underemployment in most OECD countries,

diminished expectation for long-term employment or workplace loyalty, and

stagnant or falling wages*;

Need to supplement insufficient household income;

Need to achieve costs savings coincident with rising consumerism.

Technological:

The network effect potential of combining the internet with mobile devices;

The very low marginal costs associated with sharing information and

creating networks using web-based platforms;

Rising capability to automate certain low-cost and middle-management jobs;

Increasing availability and declining costs of online payment systems.

* See http://www.oecd.org/els/societyataglance.htm and http://money.cnn.com/2014/11/20/news/economy/america-part-time-jobs-poverty/

P2P network growth reflects a confluence of economic, technological, social, political and environmental factors

http://www.oecd.org/els/societyataglance.htm

http://money.cnn.com/2014/11/20/news/economy/america-part-time-jobs-poverty/


Social:

Desire for more flexible working hours*;

Substantial rise in freelance work†;

Consumer preference for novelty, variety and convenience;

Consumer dissatisfaction with service quality for some incumbent providers;

Maturation of cultural shift toward comfort with personal on-line

relationships.

Political:

Failure of governments to improve transportation and other infrastructure in

line with population growth and the demand of residents in congested cities‡;

Rising government debt and dissatisfaction with public service efficiency and

quality;

Reduced capability of labor unions to provide benefits to traditional work

arrangements.

Environmental:

Rising preference for less pollution, greenhouse gas emissions, and waste.

DMCs: P2P networks on steroids

Essentially, a distributed marketplace company is a P2P network on a much

larger scale than possible in the past. The automated platform becomes the

conduit of market information, reducing the need for paid employees and thus

lowering the cost of operations. Because the flow of information can include

anyone inside or outside the company, the platform reduces the need for strictly

defined firm boundaries. (Uber substitutes thousands of taxi dispatchers and

their supervisors with an automated smartphone app that provides consumers

with data about driver availability and trip pricing previously only available

within taxi companies.)

As the size of the P2P community grows, the likelihood that a user will be

matched with a suitable provider grows exponentially. Eventually, the network

effects allow the platform to sidestep the centralized production and distribution

functions of corporations. For some goods and services, this will reduce slack,

because it avoids mass production in favor of precise targeting of consumer

* http://www.ey.com/US/en/About-us/Our-people-and-culture/EY-study-highlights-people-want-flexibility † http://freelancersunion.org/53Million ‡ See http://www.cfr.org/infrastructure/transportation-infrastructure-moving-america/p18611 and http://people.hofstra.edu/geotrans/eng/ch6en/conc6en/ch6c4en.html

http://www.ey.com/US/en/About-us/Our-people-and-culture/EY-study-highlights-people-want-flexibility

http://freelancersunion.org/53Million

http://www.cfr.org/infrastructure/transportation-infrastructure-moving-america/p18611

http://people.hofstra.edu/geotrans/eng/ch6en/conc6en/ch6c4en.html


demand with available providers. (AirBnB reduces the cost of marketing

temporary accommodation enough to allow anyone with a spare room to

participate. By doing so, the platform offers travelers not merely accommodation

but also, for some travelers, a differentiated experience possibly including the

opportunity to meet local residents with whom they share interests.)

Through such means as user-generated reviews (possibly of both consumers and

providers), the P2P self-organizes to build relationship capital and police bad

actors in a genuine, efficient manner. Nevertheless, the platform itself must also

earn trust, which may require more traditional branding and relationship-

building efforts, including maintaining a general sense that it treats providers

and consumers fairly. (Couchsurfing reduces the risk of staying with strangers

during international travel; at the same time, AirBnB and Uber both face legal

challenges to their business models from disaffected stakeholders.)

While information sharing and coordination are intrinsic to distributed

marketplace companies, trust is a resource that must be continually earned and

maintained. The company’s ability to maintain trust simultaneously among users,

providers and the platform itself is central to the investment thesis of any

distributed marketplace company.

Trust is essential in P2P market relationships…

…and must be continually earned and maintained


Business Model Taxonomy

All DMCs share the core function of bringing together consumers and providers

within a P2P marketplace. However, these marketplaces serve diverse functions

and make use of very different kinds of slack resources.

Whether these marketplaces can be sustainable depends upon whether the DMC

can create desirable value propositions for both users and providers without

succumbing to a backlash from other stakeholders, especially any incumbent

providers whose businesses may be disrupted by sharing.

In this new market dynamic, P2P marketplaces can compete directly with

incumbent corporations (Uber vs regulated city taxis), but also with independent

individual contractors (Task Rabbit vs the local plumber). P2P marketplaces can

exercise significant competitive pressure and spur changes in the market’s basic

conditions (new regulations), structure (more competitors), strategies (lowering

labor costs) and performance (a degradation of profits).

Because of the diversity of these companies, it is necessary to examine their

dynamics on a case by case basis. We have created a taxonomy to identify the

salient characteristics and key relationships in the distributed marketplace, in

order to help evaluate the risks and opportunities associated with each business.

Figure 3: Distributed marketplace: taxonomy

Resource: Assets Labor





Autonomous Directed

Provider’s potential geographic reach:

Global Local




Assets Labor

Distinction

The slack resource to be “shared” may be either a physical asset that is not used

to capacity or the provider’s time, skill, and effort. Some services will combine

the two in rough balance, and in others one or the other will predominate.

Examples

Asset Based: Airbnb (accommodation rentals), 1000 Tools (tool rentals),

Rocksbox (jewelry rentals and sale)

Labor Based: Task Rabbit (miscellaneous services), Mechanical Turk (flexible

intellectual labor), Homejoy (home cleaning services)

Opportunities

Asset-based services create value by allowing consumers to have access to the

item without the need for ownership (and often at a lower cost than ownership),

and to defray the cost of ownership for providers. Asset-based services also

appeal to those who value more efficient use of natural resources for

environmental or other reasons.

Labor-based services take advantage of weak, inefficient or undervalued labor

markets in developed countries to enable both providers and consumers to make

more deliberate choices regarding the trade-off between time and money

(providers turn free time into cash; users turn cash into free time or additional

time for a higher-value activity). Many advocates highlight the desirability of

flexible work hours for some providers. In developing countries, labor-based

services offer a new source of income for low-income individuals and

communities. For example, tasks assigned through Mechanical Turk can be

performed from anywhere. While fees seem low in developed countries, they

may provide substantial opportunities in low-income countries.

Risks

Asset-based services nearly always threaten incumbents because they substitute

for an outright purchase of an existing product. Politically influential incumbents

may seek to raise costs to the P2P network or eliminate it outright.

Labor-based services face three possible risks: (1) The price needed to entice

consumers may be insufficient to attract providers away from other paid

activities or their own leisure; (2) incumbents may advocate for regulatory restrictions on the P2P citing the claim that “on-demand” labor reduces job

security, puts downward pressure on wages and provides few opportunities for

advancement relative to traditional service providers; and (3) the status of

providers (employee? contractor?) may be uncertain.

Key considerations: How do income levels of providers differ from those of individuals employed by incumbents doing similar work? If different, how do provider incomes differ from other earning opportunities available to those providers? What forms of ownership or occupation are replaced by the service or product? Is there agreement between the DMC and its providers regarding the relationship? For labor-based companies, could the DMC assume more of the labor role over time through further automation?


Cooperative For-profit

Distinction

The original technology-based sharing economy companies were mission-

oriented cooperatives; more recently, entrepreneurs have emerged to monetize

P2P networks.

Examples

Cooperative: Kiva (microfinance), Outpost Natural Foods (food cooperative),

Khan Academy (education)

For-Profit: Uber (taxi), Airbnb (hospitality), eBay (retail auctions)

Opportunities

Cooperative: For investors, there are few opportunities within the not-for-profit

sector. However, these organizations are at an advantage in building a network

of like-minded users and providers who share their mission and values.

For-Profit: Other than profit itself, the reason to incorporate as a for-profit is to

achieve scale and obtain access to financing that enables investment in product

and service quality.

Risks

Cooperative: The growth of cooperatives is limited because of a lack of

investment and the difficulty of maintaining a community ethos as the network

grows. Moreover, not-for-profits are often in danger of being overtaken by

enterprises with the wherewithal to invest in product and services.

For-Profit: For-profits may be at risk of forfeiting the reputational benefits that

mission-driven organizations enjoy, especially if the mission was a primary

reason for participation in the P2P network. For-profit companies may face

concerns either from the public or from within the P2P network about the

fairness of the distribution of gains from the enterprise. For-profit companies

may also be perceived as the greater threat from incumbents.

Key considerations: How important is “community” to the network of users and providers? How does additional capital aid growth of the company? How will the distribution of benefits and risks change after the transition to a for-profit structure?


Regulatory clarity Regulatory ambiguity

Distinction

Some models operate within existing, clearly defined regulatory frameworks, or

in an unregulated market. Others may operate according to different standards

than incumbent competitors, creating ambiguity about compliance requirements.

Examples

Regulatory Clarity: Rocksbox (jewelry renting), Fon (wifi sharing)

Regulatory Ambiguity: Uber, Airbnb, Task Rabbit but also Homejoy (cleaning

services), Lyft (taxi), RelayRides (car rental), SideCar (car sharing)

Opportunities

Regulatory Clarity: Operating within an existing regulatory framework provides

a certain amount of business certainty to investors. Moreover, there are

reputational benefits to operating in a clearly compliant fashion.

Regulatory Ambiguity: There may be cost benefits as well as additional business

model flexibility, especially around labor arrangements. Moreover, the company

may successfully challenge outmoded or inefficient regulatory structures.

Risks

Regulatory Clarity: A commitment to full compliance may expose the company to

risk if regulations change, especially in response to incumbents seeking

advantage over the P2P. Moreover, stringent regulation can impede the

flexibility of P2P networks to reduce costs through efficiencies.

Regulatory Ambiguity: There is a risk that regulatory ambiguity may not be

sustainable, and that perceptions of the DMC as a scofflaw may empower

incumbents or regulators seeking to impose restrictions on the company.

Moreover, trust in the DMC may erode if users and providers perceive that they

are ineligible for the protections that regulations afford.

Key considerations: What protections are unavailable to P2P participants that would be available through incumbents? What would the costs of full compliance mean for the competitive advantage of the DMC? To what extent do regulations protect incumbents? What privacy concerns might deter participation by either providers or consumers?


Pioneers Disruptors

Distinction

Sharing economy entrepreneurs can create brand new models where there has

been limited or non-existent supply by traditional corporations; or, they can

challenge directly established monopolies and incumbent corporations. Pioneers

develop markets that previously took place only through personal relationships;

Disruptors bring greater efficiency or quality of service to existing markets.

Examples

Pioneers: Fon (wifi sharing), Rocksbox (jewelry rentals), Medicast (medical

care)

Disruptors: Lyft, SideCar, RelayRides, FlightCar (all in the individual on-demand

transport segment)

Opportunities

Pioneers: Overcome information, coordination, and trust barriers to making

productive use of existing slack on a wide scale.

Disruptors: Reduce cost, improve service, or increase differentiation in existing

markets whose inefficiencies drive high slack or fail to adequately match buyers

and sellers.

Risks

Pioneers: The risk for pioneers is that the market never establishes itself, which

could happen for a number of reasons: failure to reach scale to take advantage of

network effects; failure to attract both providers and consumers at a single price

point or within a specific pricing structure; competition in an unprotected

market with low initial barriers to entry.

Disruptors: Disruptors can be confident of the market, but also face resistance

from incumbents; regulatory hurdles; and the risk of failure to provide a service

that both users and providers deem preferable to existing options.

Key considerations: What is the comparative advantage of the DMC/P2P over incumbents? Does that advantage place any P2P participants at a disadvantage relative to similarly placed stakeholders of incumbents? To what extent does the success of the company depend on market conditions (e.g. low wages/high unemployment) that may not be sustained? How well organized are incumbents to combat potential rivals?


Amateurs Professionals

Distinction

Providers may participate in the P2P as a primary occupation or significant

source of income, or they may participate merely to take advantage of a specific

resource in their possession or to turn free time into cash. Companies fall along a

continuum in this category rather than being predominantly one or the other.

The tendency is to increase the proportion of professionals over time.

Examples

Amateur: Couchsurfing (hospitality)

Professional: Some eBay, AirBnB, Task Rabbit (home services)

Opportunities

Amateur: There is a greater opportunity for providers to become users if they do

not depend on it for their livelihood as well as less risk of labor issues, resulting

in a larger potential network.

Professional: Professional service-providers may offer more consistent

availability and potentially superior service quality.

Risks

Amateur: Consumers may be concerned about the lack of insurance, potentially

inferior service quality and uncertain supply volume or consistency.

Professional: Compared to other professional options, these opportunities may

lack traditional employee protections and benefits and limited growth potential

for providers.

Key considerations: If the P2P is shifting from amateur to professional, is there a potential crowding out of any market participants? Does the shift from amateur to professional imply any rising expectations for compensation among providers? Will the company be expected to take on greater responsibility for providers? Do consumers care if they are served by amateurs or professionals? What are the regulatory implications as providers become established businesses themselves?


Autonomous Directed

Distinction

DMCs can differ in the degree of autonomy exercised by providers and users in

setting the terms of transactions, including pricing, service quality, return policy,

etc. Some DMCs exist entirely to facilitate exchanges between autonomous

actors, while others direct the terms of transactions to varying degrees.

Examples

Autonomous: Etsy, Share My Storage (individual storage rental)

Directed: Uber

Opportunities

Autonomous: These business models offer transparent, market-based price-

setting and greater ability of providers to differentiate their own products and

services.

Directed: More directed business models feature certainty for providers and

users about pricing structures and service expectations as well as potentially

easier participation for providers.

Risks

Autonomous: There is a risk that equilibrium price point falls below living wages

for providers, or that setting prices or service terms becomes difficult.

Directed: The most directed DMCs may be indistinguishable from traditional

companies, raising questions about the employment status of providers

(contractor, employee, franchisee), and also about a possible power imbalance

between DMC and provider – in the case of Uber, for example, creating the

perception that low prices are intended to squeeze providers to gain volume for

the DMC.

Key considerations: Will P2P providers demand a greater share of gains, especially if the DMC can derive economies of scale and the P2P providers cannot? What is the risk that local regulators find that the company employs its providers? What risk is there to DMC margins if the equilibrium price is insufficient to attract both providers and consumers? Are these companies truly “sharing economy” companies or are they traditional companies? What is the likelihood that these companies automate some of the functions now performed by providers as technology improves?


Global Local

Distinction

Some DMCs enable transactions without regard to the location of provider and

consumer, while others require the market participants to be physically near

each other while operating by global principles. The nature of the product or

service determines the importance of geographic co-location.

Historically, DMCs operating locally offered primarily low-wage/low-skill

services, but with the establishment of DMCs dedicated to medical or legal

services, this may be changing.

Examples

Global: Mechanical Turk, Etsy

Local: Uber, Task Rabbit, Medicast, Instacart (grocery delivery), Vint (fitness

instructors on demand)

Opportunities

Global: Global business models offer wider market for providers, global reach for

consumers, opportunity for income in remote or economically marginal

communities and cultural exchange which may be appealing to participants.

Global DMCs primarily offer digitized or shippable products and services.

Local: Restricting operations locally enables industry in low-income areas to

thrive without global competition. Of course, many business models can only

function locally (e.g. home cleaning, taxis, etc.)

Risks

Global: Like all globalized industries, there may be the perception that the DMC

exports local jobs and enables “the race to the bottom.”

Local: Local businesses suffer from limited network effects. They may also be

dependent on local economic inequality, depending on the nature of the service:

certain kinds of services will require consumers with high disposable income and

providers willing to accept low wage work.

Key considerations: What is the likelihood that the DMC is held responsible for labor conditions that are unacceptable to consumers or in home countries? To what extent may the company be the target of wage-related discontent? Can the company grow in sparsely populated areas or is growth limited to dense cities?


Applying the DMC taxonomy

To illustrate how one can use DMC characteristics to evaluate where a company

may fall on the continuum of these indicators, we use Uber and Etsy as examples.

The assessment below is not intended to be scientific—it’s based more on our

sense of where Uber and Etsy land on these core factors.

Figure 4: Applying the DMC taxonomy to Etsy and Uber

Resource: Assets

Labor





Autonomous

Directed

Provider’s potential geographic reach: Global

Local



We also take a more quantitative approach to analyzing the opportunities and

risks for Uber, and glean insight from Cargomatic’s Co-Founder and CEO,

Jonathan Kessler.

Why take a closer look at Uber now?

Uber’s CFO, Brent Callinicos, announced last month that he’s stepping down,

sparking speculation that he’s making way for a CFO with more Wall Street

experience who can take the company public. An IPO in the in near term isn’t

certain, however, given Uber’s success raising capital in the private markets as

well as the ongoing regulatory issues Uber is facing globally.

Regardless of the potential timing of an offering, the numbers surrounding Uber

cannot be ignored. It has raised $6.5-7 billion in funding at a valuation of

approximately $50 billion, and some believe the company could be worth more

than $100 billion in the event of an IPO. Should this occur, Uber could become a

proxy for sharing economy companies, thereby influencing investor perception

and the ability for peers to raise capital in the private and public markets.

Uber could become a proxy for sharing economy companies


To this end, we consider Uber within the context of our work on distributed

marketplace companies. We focus specifically on the economic proposition for

Uber driver-partners (drivers), as Uber’s ability to attract and retain drivers is

crucial to growth. We build upon existing analysis to estimate net after-tax

earnings of Uber’s drivers relative to taxi drivers and chauffeurs. This provides insight into Uber’s flexibility on compensation in the event social or regulatory

issues result in higher costs.

Driver-partner growth is key to Uber’s value

We believe there are three key drivers of Uber’s value – all of which are impacted

by driver growth.

Size of the total available market

If we assume the global taxi and limousine market constitutes Uber’s total

available market, then sizing the market opportunity is fairly straightforward.

However, it’s possible that Uber could extend its reach into other markets (i.e.

moving vehicles) or grow the overall market for taxis and limos. While further

work is warranted, it’s possible that Uber reaches a point in terms of price and

convenience that, for a percentage of the population, it becomes an alternative to

owning a vehicle.

In order for this to occur, however, Uber must grow its driver pool to the point

where customer demand can be reliably satisfied. The level at which the service

becomes “reliable” may vary, but we’d expect the bar to be high for those willing

to forgo vehicle ownership and instead rely on Uber.

Market share captured by Uber

In January 2015, CEO Travis Kalanick said revenues in San Francisco, the

company’s most mature market, were running at $500 million annually. This

compares to overall taxi market revenues of approximately $150 million per

year, demonstrating that Uber can not only grow the total available market, but command substantial share in a traditionally fragmented industry.

This also highlights the importance of the network effect. Drivers want to be part

of the network with the most consumers so they spend more time driving and

less time waiting for calls. At the same time, consumers want to use the service

with the most drivers so they have a higher likelihood of getting a cab quickly.

First movers typically have an advantage when strong network effects exist.

While Uber appears to be well positioned as the first mover, the company must

continue to attract drivers to its platform to grow market share and fend off

competition.

Uber’s ability to attract and retain drivers is crucial to growth


Percentage of gross receipts kept by Uber

As stated above, a larger driver pool has strong network effects, which results in

increased ride volume. This, in turn, allows Uber to lower prices for customers.

In the absence of increasing volume, it may be difficult for Uber to lower prices

without taking a larger percentage of gross receipts to maintain its margins.

Earnings analysis: Uber driver-partners vs taxi drivers and chauffeurs

Given the importance of attracting and retaining drivers, it’s informative to

understand why drivers are attracted to Uber’s platform. A report* released

earlier this year titled “An Analysis of the Labor Market for Uber’s driver-

partners in the United States,” notes that drivers are attracted to Uber’s platform

primarily due to “the flexibility it offers, the level of the compensation, and the

fact that earnings per hour do not vary much with hours worked, which

facilitates part-time and variable hours.” In other words, the two key

considerations are flexible hours and pay.

While the appeal of setting one’s own hours shouldn’t be ignored, it’s difficult to

quantify because flexibility is valued uniquely by each driver. Therefore, we

focus on the other motive – the level of compensation. The aforementioned

report concludes that Uber drivers generally receive higher earnings, at $19.19

per hour, than their general-population driver counterparts (OES taxi drivers and

chauffeurs†), at $12.90 per hour. However, the analysis doesn’t account for

expenses incurred by Uber drivers and therefore doesn’t provide an apples-to-

apples comparison.‡

Building upon the data provided in the report, we estimate the expense-adjusted,

after-tax earnings of both groups and conclude that a material compensation

benefit doesn’t exist for Uber drivers. Specifically, Uber drivers realize an

after-tax net income of $8.36 per hour, while taxi drivers and chauffeurs take

home $8.16 per hour. Figure 5 details our assumptions and calculations used to estimate Uber drivers’ income.

* https://s3.amazonaws.com/uber-static/comms/PDF/Uber_Driver-Partners_Hall_Kreuger_2015.pdf † The Bureau of Labor Statistics manages the Occupational Employment Statistics (OES) program, which produces employment and wage estimates annually for over 800 occupations. ‡ The authors recognize this and suggest that “a detailed quantification of driver-partner costs and net after-tax earnings is a topic of future research.”


Figure 5: Uber driver-partner income analysis – net of expenses and taxes

Source: Hall-Krueger, Business Insider, Cornerstone Capital Group

There are two assumptions that meaningfully impact the results of this analysis:

Tax deductible expenses. Uber drivers benefit from what we believe is the

ability to reclassify personal expenses as business expenses. In 2014, the

standard mileage rate used to calculate the deductible cost of operating an

automobile for business was $0.56 per mile. This rate is broken down into fixed

and variable components.

What makes this notable is that fixed expenses would still be incurred regardless

of whether the vehicle owner drives for Uber. Using AAA data, we back out fixed

costs except depreciation, which is directly associated with operating a vehicle.

We are left with the variable portion (fuel, maintenance, tires and depreciation)

and use this to estimate an “actual” cost to Uber drivers of $0.39 per mile. This

implies Uber drivers see an approximate $0.17 per mile tax deductible benefit.

This benefit is significant – without it, Uber drivers would see hourly after-tax

net income of $7.91 instead of $8.36. This dynamic is not as impactful for taxi

drivers and chauffeurs because they don’t typically own the vehicle and therefore

don’t incur fixed costs.

Uber drivers benefit from ability to reclassify personal expenses as business expenses.


Deadhead multiplier. Dead mileage (also referred to as “dead heading”) is when

a vehicle operates without carrying or accepting passengers. Based on our

research, we assume an Uber driver realizes 0.75 deadhead miles for every

passenger mile. Going forward, it’s possible that as Uber’s ability to optimize the

dispatch function will improve as its driver pool grows. This would reduce deadhead mileage and costs for Uber drivers.

All else equal, lowering the deadhead multiplier to 1.5x from our 1.75x baseline

assumption increases Uber driver hourly after-tax net income to $9.14 from

$8.36.

Our assumptions and calculations used to estimate income for taxi drivers and

chauffeurs are shown in Figure 6.

Relative to Uber drivers, taxi drivers and chauffeurs are a less homogenous

group and their compensation and expense structure varies. For instance, some

drivers own a medallion and a vehicle, others own a vehicle but lease the

medallion, and a third group leases both. Because of this variability, we cross-

check our analysis with data provided by Seattle’s Finance and Administrative

Services division.* After factoring in payroll and income taxes, we determine that

our estimate falls within a similar range.

Figure 6: Taxi driver and chauffeur income analysis – net of expenses and taxes

Source: Hall-Krueger, Salary.com, AAA, Cornerstone Capital Group

Investment implications

To be clear, Uber hasn’t publicly disclosed a considerable amount of financial

data, and further disclosure (i.e. through an IPO prospectus) would provide an

obvious benefit to this analysis. Based on analysis of available data, our research

suggests that there isn’t a material compensation benefit for Uber drivers

relative to their general-population driver counterparts on a net after-tax basis.

This has the following implications:

* http://clerk.seattle.gov/~public/meetingrecords/2013/taxi20130314_1a.pdf

No material compensation benefit for Uber drivers


If investors assume Uber’s compensation is a differentiator in attracting

drivers to its platform, then this highlights a potential risk. Top-line

growth will come from growing the total available market and winning

market share, but is dependent on growing the driver pool. If prospective and

existing drivers begin to view their compensation through the same lens as our analysis, then Uber driver growth – and ultimately revenue growth –

could fall short of expectations.

Uber’s ability to take a larger share of gross receipts is uncertain. Uber

and other ride sharing companies (i.e. Lyft) are facing important regulatory

questions — most notably whether drivers are, in fact, independent

contractors. This is important because companies have no obligation to

provide the same worker protections for independent contractors as they do

for employees. These protections include workers’ compensation, health

insurance and paid sick days. If drivers are ultimately deemed employees of

Uber, costs would likely increase.

In the face of higher costs, we question whether Uber could take a larger

share of gross receipts without jeopardizing its ability to attract drivers to its

platform. Some suggest Uber could raise prices. This is a topic of further

research, though Uber’s recent price cuts and increasing competitive

pressure leads us to believe this wouldn’t be a preferred strategy.

Reducing deadhead mileage is a key opportunity for Uber. Presumably,

Uber should be able to leverage historical customer ride data to improve its

platform and more efficiently match supply with demand. Combined with a

growing partner-driver pool (increased driver coverage), Uber has the

opportunity to reduce deadhead miles for partner-drivers. Not only does this

reduce costs for partner-drivers, but customer wait times should benefit as

well.

Interview with Jonathan Kessler –

Co-Founder and CEO, Cargomatic

Prominent examples of distributed marketplace companies (DMCs) span across a

wide range of industries. Cargomatic, considered by some to be “the Uber for

truckers,” is leveraging technology to connect local shippers with carrier

companies who have extra space in their trucks. We interviewed the CEO and Co-

Founder, Jonathan Kessler, to gain a better understanding of the risks and

opportunities facing Cargomatic and, in some cases, DMCs broadly.

You’ve been called the “Uber for truckers.” Is this accurate?

We prefer to think about our business as a platform that connects shippers and

qualified carriers who have unutilized capacity on their trucks.

https://www.cargomatic.com/


Most things around you are transported on a truck – specifically local trucks – to

and from warehouses and retail locations. The question is how we shift to a

model where everything is on-demand. We believe in utilizing existing

infrastructure and introducing transparency and real-time efficiency to improve

asset utilization rates. Cars are only used 3-5% of the time while truck utilization is around 50%. While this is quite a bit higher, utilization can still increase

significantly.

At the end of the day, the democratization of technologies is enabling us to more

efficiently allocate otherwise underutilized assets.

Where are you currently operating and what’s the market opportunity?

Cargomatic fully launched in January 2014 and our coverage area is primarily

Southern California. We also have a presence in the Greater New York area.

Both supply- and demand-side fragmentation creates opportunities for

technology to come in and improve efficiencies. In Cargomatic’s marketplace,

fragmentation is especially high on the supply side. The large majority of

trucking companies are small — 85% of their clients have six or fewer trucks and

30% are single truck operators. When carriers are very small, it’s likely that

marketing isn’t a strong point, so Cargomatic supports them in marketing and

selling their services. We’ve already seen a number of clients purchasing new

trucks in response to greater demand for their services.

Overall, we see a $77 billion market opportunity in the US, though markets aren’t

too different in Europe, South America and Asia. There’s no reason the model

can’t be replicated internationally.

For those that choose not to work with Cargomatic, what reasons do they

cite?

Simply put – it’s a new concept. It takes time to build trust. We’ve been

expanding on mostly a referral basis. We have a sales force but we’ve yet to

advertise.

What does the competitive landscape look like?

There are a few small companies doing this in long-haul, but they’ve yet to see a

major competitor on the short-haul side.

Furthermore, Cargomatic isn’t a threat to large trucking companies. In fact, some

of these companies utilize Cargomatic as a capacity solution. If a company has

500 trucks but has a sudden spike in demand requiring 1000 trucks, they’ll

utilize Cargomatic’s platform to match up that excess demand with underutilized

supply in real-time.


We’re not overly concerned about large companies creating competitive

technology. Their strength is in buying and managing assets – not developing

technology.

Can you talk about the economics of Cargomatic’s service? What is the

revenue split between Cargomatic and carriers?

Cargomatic sells to the shippers and buys from carriers at different prices, and

thus realizes a profit based on that spread. Our margin may change depending on

market conditions, such as supply and demand in various geographies.

This model works well for smaller companies because, as mentioned before,

technology is enabling them to operate and compete at the same level as larger

companies.

Are there challenges or concerns from a regulatory perspective?

For trucking, regulations exist mostly on the federal level opposed to the state or

municipal level like with ride-sharing. This makes addressing and complying

with regulation much easier.

Is the ride-sharing “independent contractor vs employee” debate

applicable to truck drivers using Cargomatic’s platform?

We’ll see how it plays out but it’s not top of mind for us. For most of our clients,

Cargomatic-driven business represents only 20-30% of their overall business.

Dedicated “Cargomatic” trucks will likely continue to be a very small part of their

business whereas there are plenty of Uber and Lyft drivers driving full-time for

those companies. More broadly, the reality of new marketplaces is that existing

laws and regulations need to catch up with technology.

Staying on the regulatory topic, can Cargomatic be held responsible if a

truck is an accident while carrying Cargomatic cargo?

We ensure that all trucks authorized by Cargomatic have (basic) insurance.

Moreover, Cargomatic provides umbrella insurance that acts as a contingent

policy for amounts over and above the carrier’s policy. It’s rare that a carrier’s

coverage isn’t adequate—perhaps in 0.1% of transactions—but Cargomatic

absorbs this cost in these cases. That said, this amount is close to negligible for

us.

How do you provide quality assurance for carriers given they aren’t

employees of Cargomatic?

We use big data and keep scorecards for carriers. If they’ve done a poor job, we

contact them and try to deal with this. If poor service continues, we de-authorize


them from our system. We’ve de-authorized somewhere around 25% of carriers

but this number is coming down as we educate our carriers.

If you’re going to invest in “sharing economy” companies, which factors,

issues and business drivers would be critical in your decision?

I’d look for a large market that’s highly fragmented – at least on the supply side. I’d look for incumbents that aren’t technologically savvy and of course would

look for a management team that can execute. I’d also consider the nature of the

types of transactions they do, and whether significant regulatory hurdles are

present.

John K.S. Wilson is the Head of Corporate Governance, Engagement & Research at Cornerstone Capital Group. John has over 16 years of experience in socially responsible investing and corporate governance. Previously, he was Director of Corporate Governance for TIAA-CREF, where he oversaw the voting of proxies at CREF’s 8,000 portfolio companies and engaged in dialogue with corporate boards and management to promote sustainability and good corporate governance. An Adjunct Assistant Professor at Columbia Business School, John is also a member of the Advisory Council to the Sustainability Accounting Standards Board. He writes and presents widely about the relevance of social responsibility to investment performance.

[email protected]

Margarita Pirovska is the Policy & Sustainability Analyst at Cornerstone Capital Group. She has over 12 years of experience in international energy markets and sustainable business, working for GDF SUEZ, the International Energy Agency, and Gaz de France. Margarita has a Ph.D. in Economic Science from the University Paris Dauphine, a Master’s in Industrial Organization and a BA in Applied Economics.

[email protected]

Michael Shavel is a Global Thematic Analyst at Cornerstone Capital Group. Prior to joining the firm, Michael was a Research Analyst on the Global Growth and Thematic team at Alliance Bernstein. He holds a B.S. in Finance from Rutgers University and is a CFA Charterholder.

[email protected]





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